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The FOMC Keeps the Federal Funds Rate and QEII Unchanged

The Federal Open Market Committee met to discuss the course of monetary policy, and, as expected, the Committee decided to keep the federal funds rate unchanged and to keep QE2 -- the $600 billion dollar asset purchase plan -- unchanged as well.

The press release indicates that the committee does see the economy as being on firmer footing than it did in the last few meetings, but the improvement wasn't anywhere near enough to cause the Fed to seriously consider changing course. In addition, the recent rise in commodity prices is noted, but the stability of the general price level, the stability of inflation expectations, and the general state of the economy led the Fed to conclude that inflation is not yet a worry. But they clearly have their eyes on this, but the Committee notes that current conditions indicate "exceptionally low levels for the federal funds rate for an extended period."

One additional point. This is the first meeting of the new year, and as happens every year, the voting members of the FOMC change. In particular, Thomas Hoenig -- the lone dissenter in recent meetings -- is now a non-voting member and three district bank presidents known to be relatively hawkish, Charles Plosser of the Federal Reserve Bank of Philadelphia, Richard Fisher of the Dallas Fed, Narayana Kocherlakota of the Minneapolis Fed are now eligible to vote (only 5 of the 12 district bank presidents vote in a given year; the NY Fed president is always a member, and the other 4 positions rotate annually -- see here for more details). It wasn't clear how the new members would vote. It was expected that the fourth new member, Charles Evans of the Chicago Fed, would vote with the majority, but the other three votes weren't as clear. I was at least slightly surprised that there were no dissents at all.

Here's the press release describing the meeting:

Press Release, Release Date: January 26, 2011, For immediate release: Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Update: From my colleague Tim Duy:
Quick FOMC Response, by Tim Duy: The FOMC statement was largely as expected â€" sticking to the current policy path. That means maintaining the current asset purchase program while holding interest rates low for an extended period. Some specifics:

No Dissents: Kansas City Fed President Thomas Hoenig is no longer a voting member, and none of the new voting members took up his dissent. Completely unsurprising. While some policymakers such as Philadelphia Fed President Charles Plosser believe that QE2 was a mistake, they see the costs â€"market disruption and loss of credibility â€" of undoing that mistake as greater than the benefits.

Additional Flexibility: Note the change in the first sentence.
From:

Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.
To:
Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions.
A focus on a specific data point â€" unemployment â€" was replaced with the more general "labor market conditions." This could signal a willingness to roll back the balance sheet expansion if nonfarm payrolls were growing rapidly but, as workers return to the labor force, unemployment rates remain persistently high. I have difficulty seeing the Fed raise rates as long as unemployment is high, but a return to allowing the balance sheet to contract naturally or directly would not be out of the question.

Commodity Prices: As expected, the FOMC is not poised to follow the path of ECB Head Jean-Claude Trichet and fret about headline inflation. In contrast, the FOMC will focus on the pass-through to core inflation, if any, and the path of longer term inflation expectations.

Bottom Line: No real surprises in this FOMC statement, with the exception of a slight change in language on labor markets that suggests an effort to create additional flexibility.

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